Fujifilm should beware the Xerox trap

Post-deal structure could embroil Japanese group in US-style investor disputes

Billionaire American investor Carl Icahn has generated a lot of noise with his vociferous assault on the $6.1 billion deal in which Japan's Fujifilm plans to take control of Xerox of the U.S.

But the real risk to FujiFilm is not that Icahn's loud complaints could kill the deal or drive up the purchase price. It is that all the sound and fury is distracting attention from the quiet trap awaiting the Japanese group if the transaction goes through. A trap so risky that Fujifilm would be well advised to walk away now.

Xerox management, under pressure from Icahn and other hedge fund shareholders to "do something" to generate value from a once-iconic company struggling in a declining photocopier market, has persuaded Fujifilm to agree to buy bare majority 50.1% control of Xerox, but leave the remaining 49.9% in the hands of public shareholders, including Icahn and some hedge funds. In a complex arrangement, Fujifilm is paying out no cash but acquiring controlling stake by folding Fuji Xerox, a long-established joint venture between the two companies, into Xerox.

The proposed deal creates an ownership structure that is common in Japan but fraught with risk in corporate and legal environments outside Japan, not least the U.S.

Right now, Icahn is bitterly complaining that the price Fujifilm is offering is a "terrible deal" and not "good enough." Only time will tell whether he succeeds in ratcheting up the price for Xerox shares. But, for Icahn, getting Fujifilm to buy 50.1% of Xerox is just Act I in a two-part drama. Act II is the climax, certain to be filled with lawsuits and pious rhetoric about "minority rights," in which Icahn will have an opportunity to squeeze out an even higher price for the remaining 49.9%.

Fujifilm's long-serving chairman and CEO Shigetaka Komori is one of Japan's most admired businessmen, widely credited with saving Fujifilm from disaster as its traditional market -- photo film -- collapsed. But even he may not have grasped the problems lying ahead.

For most Japanese business executives, accustomed to domestic Japanese norms, nothing would smell suspicious about Xerox's ownership structure following Act I. The phenomenon of one listed company owning another is widespread and uncontroversial in Japan. About 300 listed Japanese companies (out of 3,000 total) have exactly the same ownership structure, commonly referred to as "parent-child listed companies" (oya-ko jojo kaisha) or "listed subsidiaries."

But this ownership structure is almost unheard of in the U.S. In sharp contrast to Japan, U.S. corporate law and corporate governance principles are highly sensitive to the conflicts of interest that inevitably arise between a controlling majority shareholder and minority shareholders. These conflicts of interest are viewed as particularly threatening to minority shareholders in cases where the majority shareholder conducts ongoing business transactions (for example, a supply relationship) with the entity it controls. The concern is that the majority shareholder will use its majority control to dictate unfair terms, to the detriment of the minority shareholders. Unlike in Japan, in a U.S. court the majority shareholder will carry the burden of proving that each transaction with the controlled entity is scrupulously fair and at arm's length. U.S. companies therefore almost never create ownership structures that expose them to this kind of conflict of interest claim from minority public shareholders.

In letters he has issued since the Fujifilm-Xerox deal was announced, Icahn has already given a preview of Act II. He paints a lurid post-acquisition picture of "big brother" Fujifilm abusing its position as 50.1% controlling shareholder of Xerox to "live in a mansion and drive a Rolls-Royce while the younger brother lives in shack and drives an old beat-up hatchback." Icahn may already be mentally drafting the lawsuits to come in Act II, accusing Fujifilm of "abusing" its majority control to siphon off Xerox's assets and technology for the benefit of the Japanese "big brother" to the detriment of the American "little brother."

To add to the irony, the justification offered for Fujifilm's acquisition of Xerox is that it will lead to multiple cost-saving, value-enhancing "synergies" between the two companies. But these synergies cannot realistically be achieved under the constant threat of an Icahn lawsuit accusing Fujifilm of stealing or undervaluing Xerox assets, technology, customers and people. Realizing synergies requires both parties to act and think like a single firm, without worrying whether each individual transaction is "fair" or conducted on "arms-length" terms. The ownership structure of Xerox will make impossible the very synergies that are being advertised to sell the deal.

Icahn's endgame, naturally, is to assert his minority rights loudly in Act II as leverage to get Fujifilm to buy the rest of Xerox at an even higher price. Knowing this, an obvious question for Fujifilm is, "If Xerox is such a great company, why not buy the whole thing now?" Of course, an honest answer -- that he wants the minority shareholders to share the risk that Xerox is not such a great company after all -- plays right into the hands of Icahn.

Fujifilm's planned acquisition of a bare majority of Xerox raises the usual concerns about overseas M&A by Japanese companies -- that the price is too high and that the Japanese acquirer lacks the capacity to manage the foreign acquired company. But it raises an additional concern -- that Fujifilm miscalculates the pitfalls of an ownership structure in an unfamiliar legal environment outside Japan.

Stephen Givens is a practicing corporate lawyer based in Tokyo. He is concurrently a professor in the Law Faculty of Sophia University.